You can’t keep a good China bull down. After a brief flirtation with notions of a hard landing, the conventional wisdom now has it that China is poised to resume its inexorable rise to global superpower.
It is not entirely clear why the mood has changed. China has a new deck of leaders, as nobody could have failed to notice, but they are hardly very different from the old ones — and, in the meantime, the country’s other problems haven’t gone away.
Questionable accounting, unaffordable housing, tainted food and corrupt officials are all proving hard to resolve. There is also the small issue of Beijing’s hazardous “fog”, which has become a very visible example of a negative externality. But all these problems would fade into insignificance if China’s tentative recovery were to falter.
There are reasons to fear that may be the case. China continues to run the highest investment-to-GDP ratio in the world and, despite the cooling effects of the global financial crisis, its economy may be suffering from a serious investment overhang.
Indeed, Standard & Poor’s estimates that China’s overinvestment poses a downside risk of $800 billion. The rating agency has conducted a study of investment levels in 32 countries in the run-up to two crises — the Asian financial crisis and the most recent global financial crisis — and concludes that China is at the highest risk of an investment-induced correction.
By comparing each economy's investment-to-GDP ratio against its real GDP growth, S&P determines whether the level of investment is sustainable.
“The level of a country's investment overhang can be a leading indicator of a potential economic correction,” says the study. “Specifically, an investment line above the growth line signals diminished returns on investment. If this trend was maintained over a long period, and the absolute investment-to-GDP percentage remained high, we believe there would be a greater negative impact on real GDP growth when the economy corrects.”
In China, the investment line is trending about two standard deviations above the growth line, based on a three-year moving average ending 2012. That makes it the only economy in S&P’s high-risk category.
It is no secret that China’s growth model has relied on investment rather than consumption, though the findings of S&P’s study give substance to the idea that it should act sooner rather than later. The challenge is doing something about it.
“The longer you leave it, the harder it is to cool,” said Terry Chan, a managing director at S&P in Australia. “The difficulty is how you ease investment levels without causing an economic contraction. The focus must be on more productive investment, being more selective.”
Few would disagree, even in Beijing. Time will tell if the message translates to the provinces.